Top legal advice for startups
By Chris Errico
While each startup faces its own unique set of challenges, there are a few practical steps founders can take, no matter what industry or stage of development. Below are some of our top legal tips for startups:
Find the Right Lawyer and Law Firm
Finding the right lawyer and law firm to work with your startup is important for so many reasons and the decision should not be made lightly. Recommendations from trusted referral sources are a great place to start, but entrepreneurs should always do their homework and conduct an interview process before pulling the trigger on retaining counsel. Some key considerations are laid out below but you can find more detailed information on this topic on How to choose a startup lawyer:
- Experience Working with Startups: It’s critical that your lawyer understand how to work with startup companies. Alternative fee arrangements, discounted hourly rates and project-based packages are customary accommodations offered by lawyers and law firms and you should make sure to ask about these options prior to engagement. A good startup lawyer and law firm will be your long-term partner and will understand the up-front investment needed for you to succeed.
- Industry & Sector Expertise: Your lawyer and law firm should have the requisite expertise in the industry or sector in which your startup will be operating. Representation of similarly situated companies and insight into common industry obstacles can be invaluable resources for entrepreneurs as they navigate their growth trajectory. The law firm should also have sufficient capacity to grow with your startup as its legal needs evolve.
- Chemistry & Judgment: You should have good chemistry with your lawyer. Not every lawyer is right for every company. Being an entrepreneur isn’t easy and it can often feel like you have the weight of the world on your shoulders. A good lawyer is going to be a trusted adviser and confidant in the good times and the bad. You should feel comfortable confiding in your legal counsel and trusting their judgement.
- Market Engagement: A good startup lawyer is connected to all constituent parties in the ecosystem and should be able to open doors for you when necessary. Whether it be to other service providers, accelerators/incubators, venture capitalists or other potential partnership opportunities, your lawyer should be able to do outreach on your behalf and should be actively engaged in the market.
Protect the Company’s Assets
Startups are high-risk/high-reward ventures that typically begin with every risk imaginable. As such, it is critical to establish a clean chain of ownership to your company’s intellectual property. Intellectual property isn’t just limited to patents, trademarks and copyrights, but also includes all proprietary “know how” and other confidential company information. In order to protect these assets, all agreements with third parties should be reduced to writing and should contain customary intellectual property assignment and confidentiality language. When you are ready to finally raise from a sophisticated angel or venture capitalist, this will inevitably be a major diligence point in future financing rounds. It’s important to make your startup company look as attractive as possible as investors are taking significant risk when investing in a startup and the last thing they want to see is any legal risk associated with the investment profile. It is imperative for founders to be proactive in making sure these kinds of protections are in place at the outset of any engagement with a third party.
Equity vesting schedules (or the lack thereof) are another area where founders can get themselves into trouble. Almost all startup companies begin with a group of enthusiastic founders ready to conquer the world together. However, as time goes on, distractions and unanticipated life events are inevitable. It is important that founders structure their equity ownership in a manner which not only protects the company from these unforeseen events, but also the other founders. The concept of equity vesting is relatively straightforward. Instead of granting a founder all of his or her equity outright, the grant is subject to a vesting schedule, which means that in the event the founder leaves the company prior to the vesting of all of his her stock, the founder would forfeit the unvested portion of the grant. This concept does not only apply to founders, but also to employees, advisers, directors, consultants and other service providers. The good news is that vesting schedules can be tailored in a variety of flexible ways to accommodate the many different ways companies use incentive-based equity grants to compensate an individual for services they are providing to the company. Vesting for founders is typically structured on a 3-4 year time-based vesting schedule with the associated equity vesting on a monthly basis. Consultants or advisers may be on a project-based vesting schedule tailored to the completion of certain pre-negotiated milestones or a 1-2 year time-based monthly vesting schedule.
Keep things Simple
Entrepreneurs are more often than not “outside the box thinkers,” and in an effort to create unique incentives or accommodate unusual requests from investors they can sometimes create unnecessarily complicated legal constructs. Sometimes unique circumstances arise where a complex arrangement is justified, but more often than not it just drives up legal costs and can cause diligence issues down the road. Founders need to be most cost conscious early on and this is where the judgment of a good startup lawyer can come into play to help avoid these types of arrangements.